Risk in Russia’s Realm: Omnipresent Geopolitical Danger

With much fanfare, investment in emerging markets has become increasingly popular in recent years. While there have long been specialized firms targeting specific countries and regions for investment, in recent years a remarkable level of access to emerging markets has been granted to retail investors through an explosion of index funds, active ETFs, and other investment vehicles. Backed by powerful media hype, Brazil, Russia, India, and China have been particularly thrust into the investing public’s eyes.

The world’s emerging markets are painted widely as ripe for nearly limitless growth, and many investors have cheerfully embraced their potential. However, as the current conflict in South Ossetia vividly illustrates, emerging markets around the world, including the BRICs, are frighteningly vulnerable to geopolitical volatility. Following the violation of Georgian sovereignty by 12,000+ Russian troops, Georgia’s stock exchange (www.gse.gov) suspended trading on Monday, and a call to their offices revealed they have no plans to re-open them as long as the conflict continues. 

Meanwhile, Russia’s MICEX index gave up over six percent shortly after open only to finish up nearly four percent.  But while Russia’s markets managed to tack on some dollars on Thursday, it is difficult to imagine a situation where any positive value could be added to their economy as a result of their conflict with Georgia.

Despite fiery rhetoric from both sides, the end economic result of the conflict will almost undoubtedly be a net loss for both Russia and Georgia.  In Georgia, investors not only had a rapidly developing free-market eager for capital, they had a brilliant president fiercely pursuing membership in NATO and the European Union. They had a nation in line for large sums of aid from an increasingly friendly U.S. And according to the C.I.A. World Factbook, they had the most literate nation in the world.

In short, just a week ago, Georgia had enormous economic potential, and was on track to becoming one of the Emerging World’s most eligible economies.  Now, Georgia’s people are scattered, its industries are shut down, and its leaders are in hiding. Unspecified amounts of damage have been inflicted by Russian air strikes and artillery throughout the country. Russia will likely increase the already considerable economic sanctions levied towards its southern neighbor.  Most importantly, the psychological damage done to Georgia’s economy in the eyes of foreign investors is unquantifiable.

While it is not difficult for many investors to see how investments in a developing country roughly the size of West Virginia can quickly implode in the face of sudden geopolitical pressure, it is important to note that Russia presents high levels of continuing geopolitical-related risk as well.  As the European Union reaches further towards its giant neighbor in the east, additional rows have the potential to erupt into economic and military conflicts.  Trouble with Poland or the Czech Republic would have exponentially more serious consequences than the current war in South Ossetia. As the two countries creep closer to installing components for a U.S. Ground-Based Midcourse Missile Defense System, tension will continue to rise in Moscow.

Beyond those current sources of potential trouble, former Soviet Republics will continue to reach out to the west, to the dangerous chagrin on the Russian government. Russian Prime Minister Vladamir Putin, who seems to have a solid grip on power in the Kremlin for the considerable future, remarked in 2005 that the breakup of the U.S.S.R. was “the biggest geopolitical disaster of the 20th century”. One would guess he won’t be pleased by its continued fragmentation. The current conflict proves he is not afraid to deploy the country’s military to keep Russia’s sphere of influence intact. Next time, the consequences for Russia, and its economy, could be much higher.

Russia isn’t the only BRIC member potentially subject to deadly geopolitical pressure. China’s relationship with Taiwan could still lead to serious economic isolation or worse for the PRC, should an overly aggressive government play rough on either side. India faces declining, but still serious hostility over Kashmir, in one of the few world hotspots primed for nuclear showdown.  Brazil seems comparatively safe, but could be affected by conflict amongst its northwestern neighbors.

In short, Russia’s aggressive actions over the past several days should serve to remind investors that when stockpicking in the developing world, sudden turmoil can move markets. Retail investors in particular should carefully fit such investments into their acceptable risk profiles. Because, in today’s emerging marketplaces, you never know where you might stumble into the next Georgia.

Comments

[notsosmart:]

its your money to lose.not enough courage here for russia or china.both still really dictatorships.there was acountry in the 30's that got great prestige from the olympics & it cost app.55 mil. lives.a very high price.what will the china games cost? russia has shown its true face in the last few days.

2008 Aug 12 11:02 PM